10-1 10 Reporting and Analyzing Liabilities Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 10-2 CHAPTER OUTLINE LEARNING OBJECTIVES 10-3 Explain how to account for current liabilities Describe the major characteristics of bonds Explain how to account for bond transactions Discuss how liabilities are reported and analyzed LEARNING OBJECTIVE Explain how to account for current liabilities WHAT IS A CURRENT LIABILITY? A debt that a company expects to pay from existing current assets or through the creation of other current liabilities, and within one year or the operating cycle, whichever is longer Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest 10-4 LO WHAT IS A CURRENT LIABILITY? Review Question To be classified as a current liability, a debt must be expected to be paid within: 10-5 a year b the operating cycle c years d (a) or (b), whichever is longer LO NOTES PAYABLE Written promissory note Usually require the borrower to pay interest Frequently issued to meet short-term financing needs Issued for varying periods of time Those due for payment within one year of the balance sheet date are usually classified as current liabilities 10-6 LO NOTES PAYABLE Illustration: First National Bank agrees to lend $100,000 on September 1, 2017, if Cole Williams Co signs a $100,000, 12%, four-month note maturing on January When a company issues an interest-bearing note, the amount of assets it receives generally equals the note’s face value Sept Cash 100,000 Notes Payable 100,000 10-7 LO NOTES PAYABLE Illustration: If Cole Williams Co prepares financial statements annually, it makes an adjusting entry at December 31 to recognize interest Dec 31 Interest Expense 4,000 * Interest Payable 4,000 * $100,000 x 12% x 4/12 = $4,000 10-8 LO NOTES PAYABLE Illustration: At maturity (January 1), Cole Williams Co must pay the face value of the note plus interest It records payment as follows Jan Notes Payable Interest Payable 100,000 4,000 Cash 104,000 10-9 LO SALES TAXES PAYABLE 10-10 Sales taxes are expressed as a stated percentage of the sales price Selling company ► collects tax from the customer ► remits the collections to the state’s department of revenue LO AMORTIZING BOND PREMIUM ILLUSTRATION 10B-4 Bond premium amortization schedule 10-75 LO AMORTIZING BOND PREMIUM Illustration: Candlestick, Inc records the accrual of interest and amortization of premium discount on Dec 31, as follows: Dec 31 Interest Expense 9,669 Premium on Bonds Payable Interest Payable 10-76 331 10,000 LO LEARNING OBJECTIVE APPENDIX 10C: Describe the accounting for long-term notes payable LONG-TERM NOTES PAYABLE May be secured by a mortgage that pledges title to specific assets as security for a loan Typically, the terms require the borrower to make installment payments over the term of the loan Each payment consists of 10-77 interest on the unpaid balance of the loan and a reduction of loan principal Companies initially record mortgage notes payable at face value LO LONG-TERM NOTES PAYABLE Illustration: Porter Technology Inc issues a $500,000, 8%, 20-year mortgage note on December 31, 2017 The terms provide for annual installment payments of $50,926 ILLUSTRATION 10C-1 Mortgage installment payment schedule 10-78 LO LONG-TERM NOTES PAYABLE Illustration: Porter Technology records the mortgage loan and first installment payment as follows: Dec 31 Cash 500,000 Mortgage Payable Dec 31 Interest Expense 500,000 40,000 Mortgage Payable 10,926 Cash 10-79 50,926 LO A Look at IFRS LEARNING OBJECTIVE Compare the accounting for liabilities under GAAP and IFRS KEY POINTS Similarities The basic definition of a liability under GAAP and IFRS is very similar In a more technical way, liabilities are defined by the IASB as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits 10-80 LO A Look at IFRS Similarities The accounting for current liabilities such as notes payable, unearned revenue, and payroll taxes payable are similar between GAAP and IFRS IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions) When current liabilities (also called short-term liabilities) are presented, they are generally presented in order of liquidity 10-81 LO A Look at IFRS Similarities Under IFRS, liabilities are classified as current if they are expected to be paid within 12 months Similar to GAAP, items are normally reported in order of liquidity Companies sometimes show liabilities before assets Also, they will sometimes show long-term liabilities before current liabilities The basic calculation for bond valuation is the same under GAAP and IFRS In addition, the accounting for bond liability transactions is essentially the same between GAAP and IFRS 10-82 LO A Look at IFRS Similarities IFRS requires use of the effective-interest method for amortization of bond discounts and premiums GAAP also requires the effective-interest method, except that it allows use of the straight-line method where the difference is not material Under IFRS, companies not use a premium or discount account but instead show the bond at its net amount For example, if a $100,000 bond was issued at 97, under IFRS a company would record: Cash 97,000 Bonds Payable 10-83 97,000 LO A Look at IFRS Differences The accounting for convertible bonds differs between IFRS and GAAP Unlike GAAP, IFRS splits the proceeds from the convertible bond between an equity component and a debt component The equity conversion rights are reported in equity Under IFRS, companies sometimes will net current liabilities against current assets to show working capital on the face of the statement of financial position 10-84 LO A Look at IFRS LOOKING TO THE FUTURE The FASB and IASB are currently involved in two projects, each of which has implications for the accounting for liabilities One project is investigating approaches to differentiate between debt and equity instruments The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting The results of these projects could change the classification of many debt and equity securities 10-85 LO A Look at IFRS IFRS Practice Which of the following is false? a) Under IFRS, current liabilities must always be presented before noncurrent liabilities b) Under IFRS, an item is a current liability if it will be paid within the next 12 months c) Under IFRS, current liabilities are sometimes netted against current assets on the statement of financial position d) 10-86 Under IFRS, a liability is only recognized if it is a present obligation LO A Look at IFRS IFRS Practice The accounting for bonds payable is: a) essentially the same under IFRS and GAAP b) differs in that GAAP requires use of the straight-line method for amortization of bond premium and discount c) the same except that market prices may be different because the present value calculations are different between IFRS and GAAP d) 10-87 not covered by IFRS LO A Look at IFRS IFRS Practice Which of the following is true regarding accounting for amortization of bond discount and premium? a) Both IFRS and GAAP must use the effective-interest method b) GAAP must use the effective-interest method, but IFRS may use either the effective-interest method or the straight-line method 10-88 c) IFRS is required to use the effective-interest method d) GAAP is required to use the straight-line method LO COPYRIGHT “Copyright © 2016 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” 10-89 .. .10 Reporting and Analyzing Liabilities Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 10- 2 CHAPTER OUTLINE LEARNING OBJECTIVES 10- 3 Explain how to account for current... (FICA), $6,500 for federal income tax, and $2,000 for state income tax Costs incurred for unemployment taxes were $90 for federal and $150 for state Prepare the September 30 journal entries for (a)... wages were $3,500 for Social Security (FICA), $6,500 for federal income tax, and $2,000 for state income tax Costs incurred for unemployment taxes were $90 for federal and $150 for state Prepare